AT&T-Time Warner Merger

AT&T-Time Warner Merger: Bad Deal For Investors In Both ... http://seekingalpha.com/article/4013940-t-time-warner-merge... AT&T-Time Warner Merger: Bad Deal For Investors In Both Oct. 21, 2016 3:50 PM ET202 comments by: Dividend Sensei Summary Bloomberg is reporting that AT&T is potentially in late stage negotiations to buy Time Warner. The news has sent shares of Time Warner soaring 7%, while AT&T crashes 3%.for two days in a row. BUT thanks to its large debt load from acquiring DirecTV, such a deal would likely have to be a stock funded deal.. This would result in so much shareholder dilution that the deal would be minimally accretive to AT&T's EPS, and actually result in lower FCF/share. Which would end up hurting both current Time Warner, and AT&T shareholders due to slower dividend growth going forward. On October 20th, Bloomberg reported on rumors that AT&T (NYSE:T) was looking to buy Time Warner (NYSE:TWX). The 1 von 48 23.10.16, 08:27 AT&T-Time Warner Merger: Bad Deal For Investors In Both ... http://seekingalpha.com/article/4013940-t-time-warner-merge... news sent Time Warner soaring, while AT&T shares reacted with far less enthusiasm. T data by YCharts Let's take a look at why AT&T might be interested in acquiring Time Warner, but most importantly why such a deal isn't likely to benefit investors in either company. In theory the deal makes sense AT&T has long been a high-yield dividend growth favorite thanks to the utility like rock steady cash flow provided by its telecom business. And with management's bold acquisition of DirecTV, as well as its push into the faster growing Mexican wireless market, the company has the potential to accelerate its dividend growth rate from the anemic 2% it's been delivering over the last few years. 2 von 48 23.10.16, 08:27 AT&T-Time Warner Merger: Bad Deal For Investors In Both ... http://seekingalpha.com/article/4013940-t-time-warner-merge... Source: Simply Safe Dividends By acquiring Time Warner AT&T would be doubling down on its plans to become a global media giant, thanks to Time Warner's rich content, and intellectual property. For example, purchasing Time Warner would bring the following under AT&T's tent, and turn it into a potential rival for Disney (NYSE:DIS): HBO and Cinemax Turner broadcasting, including CNN, TBS, TNT, Cartoon Network, AdultSwim Broadcast channel the CW DC Comics Warner Studios and its growing DC cinematic universe, as well as the Harry Potter franchise In a fast changing media landscape, where cord cutting is a major concern for cable providers such as AT&T, the ability to acquire content, (and thus boost pay TV margins by cutting content costs), is potentially very valuable. Which is why Bloomberg is reporting that AT&T CEO Randall Stephenson "is looking to add more content and original programming." Specifically, over the next three to five years, the company is planning on acquiring media companies, with a targeted market cap range of $2 billion to $50 billion. ...but the math just doesn't work out favorably for shareholders However, as much sense as it makes for AT&T to continue to diversify its cash flows, and build a vast, globe spanning media empire, we can't forget that its recent acquisition spree. This included $49 billion for DirectTV, and $18 billion in wireless spectrum, has left its balance sheet with far more debt than management is comfortable with. That's understandable since the DirecTV deal wound up resulting in a total of $126.8 billion in total debt, and a credit downgrade from S&P. Sources: Morningstar, Gurufocus Company Debt EBITDA Interest Debt/EBITDA EBITDA/Interest 3 von 48 23.10.16, 08:27 AT&T-Time Warner Merger: Bad Deal For Investors In Both ... http://seekingalpha.com/article/4013940-t-time-warner-merge... AT&T $126.8 billion $53.1 billion $4.754 billion 2.39 11.17 Time Warner $24.5 billion $7.8 billion $1.388 billion 3.14 5.61 AT&T + Time $151.3 $60.9 $6.142 2.48 9.91 Warner billion billion billion AT&T currently has only $7.2 billion in cash and cash equivalents on its balance sheet. And given its high debt load it's highly likely that any acquisition of Time Warner would have to be an almost entirely stock based deal. But even then, Time Warner's $24.5 billion in debt would be added to AT&T's, which would create one of the largest debt levels in corporate America. Now, that isn't to say that it would necessarily be a dangerous level of debt. After all, the average telecom's leverage ratio (Debt/EBITDA) is 2.59, and even before any synergies the larger AT&T would have a lower ratio than that. However, the fact that AT&T would be reversing its recent deleveraging efforts could result in another credit downgrade, potentially leaving the company open to higher refinancing costs as interest rates gradually rise. That's especially true given that AT&T has $5.77 billion, $6.5 billion, and $7.4 billion in debt coming due in 2017, 2018, and 2019 respectively. However, I will admit that the combined AT&T and Time Warner would make for an attractive group of assets, with some of the highest sales, earnings, and free cash flow, or FCF in the world. Company Sales Earnings Free Cash Flow AT&T $162.3 billion $14.2 billion $16.7 billion Time Warner $27.9 billion $4.1 billion $3.6 billion AT&T + Time Warner $190.2 billion $18.3 billion $20.3 billion Of course the real issue with a potential buyout of Time Warner is whether or not the deal can be structured in such a way to benefit shareholders in both companies. Company Shares EPS (Post 10% FCF/Share (Post 10% Outstanding Synergy) Synergy) AT&T 6.195 billion $2.29 $2.70 Time Warner 808 million $5.02 $4.44 AT&T + Time 8.552 billion $2.35 $2.61 Warner So let's take Time Warner's current market cap of $70 billion, add a 25% premium, and then figure out what an all stock deal would mean in terms of EPS, and FCF/share accretion. As you can see, the large amount of shareholder dilution needed to acquire Time Warner actually results in minimal EPS accretion, and a small decrease in AT&T's FCF/share. The reason that matters is because FCF/share is what secures, and funds the dividend and its growth; the primary concern of AT&T investors. In other words, without first deleveraging its balance sheet, which would allow AT&T to borrow heavily to buy Time Warner, the dilutive nature of such a deal means there really is not benefit to AT&T shareholders. As for Time Warner investors, they might also end up feeling screwed. 4 von 48 23.10.16, 08:27 AT&T-Time Warner Merger: Bad Deal For Investors In Both ... http://seekingalpha.com/article/4013940-t-time-warner-merge... Sources: Yahoo Finance, Fastgraphs, Factset Research, Multpl.com, Moneychimp.com Company Yield TTM FCF Payout Projected 10 Year Dividend Projected 10 Year Total Ratio Growth Return AT&T 5.0% 67.2% 4.0% 9.0% Time 2.0% 33.6% 9.2% 11.2% Warner S&P 500 2.1% 39.1% 6.2% 9.1% Academic studies show that a good rule of thumb for long-term total returns is yield + dividend growth. And while long-term analyst growth forecasts always need to be taken with a grain of salt, as you can see Time Warner is a much faster growing company. So in a mega-merger its shareholders would end up with a much higher-yield BUT lower total return potential. BUT WAIT! Maybe AT&T buying Time Warner could boost its own dividend growth rate and make up for the slower payout growth rate. After all, AT&T is still working on cost cutting in order to achieve synergies from its DirecTV acquisition and management expects its free cash flow to hit $20 billion in 2020. Source: AT&T investor presentation. In other words, over the next four years AT&T thinks it can squeeze another $3.3 billion in costs out of its assets. And assuming a conservative 10% synergy cost savings from eliminating redundant positions, and inefficiencies at Time Warner, by the end of 2020 the new, larger, AT&T could be looking at free cash flow of $25.6 billion per year. Sources: Morningstar, AT&T management guidance 5 von 48 23.10.16, 08:27 AT&T-Time Warner Merger: Bad Deal For Investors In Both ... http://seekingalpha.com/article/4013940-t-time-warner-merge... Scenario Projected Share 2020 2020 4 Year 4 Year 2020 FCF Count FCF/Share Dividend Dividend Projected Total CAGR Return No Merger $20 billion 5.77 $3.47 $2.43 6.1% 11.1% billion Time $25.6 billion 7.96 $3.22 $2.25 4.0% 9.0% Warner billion Merger From 2007, right after AT&T restructured, to 2014, just before it acquired DirecTV, AT&T's net buyback rate was 2.36% CAGR. Using this as a likely ongoing buyback rate, we can determine the likely number of shares outstanding at the end of 2020, and thus the ultimate FCF/share if AT&T does, and doesn't buy Time Warner.

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